Judging from the nation's position in its economic cycle, now is the time for the authorities to cut down the scale of investment funded by treasury bonds.

Diminishing governmental investment at the proper time will reduce the amount of credit granted by commercial banks for urban construction and real estate development, which is held by many as a source of over-heating in some industries.

It will also write off the over-demand for production materials and investment targets.

As a matter of fact, the governmental investment is not as strong as it used to.

The percentage of fiscal deficit in the gross fiscal spending was as high as 15.7 percent in 2000. The proportion has since been on an overall decline, indicating a weakening role of the pro-active fiscal policy in the economy.

The same trend could be seen from changes in the percentage of the long-term construction treasury bonds in the fiscal deficit.

In 1998 when the government initiated its investment drive using treasury bond funds, the amount of fiscal deficit was identical with that of long-term construction treasury bonds.

In the next three years, long-term treasury bonds accounted for about 60 percent of the fiscal deficit. The rate went down to 48.4 percent last year and is predicted to be 43.7 percent this year.

The continual drop of this rate indicates the government is cutting down the treasury bond investment.

Another sign of governmental investment cool-off is that the long-term construction treasury bonds are taking less ratio in the total bond issuance in recent years.

At its peak, the ratio was as high as 32.2 percent in 2000. It came down to 29.9 percent in 2001 and slid to 26.4 percent in 2002. This year, it is estimated to be 21.8 percent.

Therefore, it is safe to say China's economic development, especially the boom this year, has been achieved against the backdrop of a shrinking governmental investment fund.

According to mainstream theories on public finance and macro economy, the fiscal policy should be adjusted along with the change in real economic conditions.

When the economy is growing at a slower pace than its potential, the fiscal policy should be expansionary to stimulate the economy.

When the economic growth recovers, the fiscal policy should switch from being pro-active to neutral and the fiscal deficit should be gradually cut down, so the expansion of the gross demand would not swell unproportionately to dampen the enthusiasm of private investors.

China will pick up its potential growth this year and it is predicted to maintain a high annual growth of 9 percent in the coming years.

In this condition, the fiscal policy, which has focused on the expansion of treasury bond investment, has accomplished its mission.

Moreover, there is always a time lag between a policy switch and its taking effects.

The fiscal policy should be changed a bit earlier to leave a necessary buffer period to avoid dramatic ups and downs in the economy.

The time is ripe to phase out the expansionary investment mode boosted by treasury bonds.

Considering the investment demand from projects under construction, the authorities should continue to issue long-term construction treasury bonds in 2004-05, but the amount should be cut down gradually to ensure the smooth phase-out of the policy by 2006.

The fund gap arising from increased demand for developing the western region and promoting rural education and healthcare will be filled through adjusting the structure of budgetary expenditure.

Such a policy adjustment will not hold back economic growth.

In the first half of this year, investments by collective and individual investors were up by 34 and 24.3 percent respectively, registering notable growth over last year.

Investment by share-holding and foreign enterprises also grew remarkable during the same period.

It indicates that non-State investments are entering the fast track. The investment capital structure has changed remarkably, and the economy no longer depends as heavily on the treasury bond investment as it used to.

Therefore, the gradual reduction in treasury bond investment will not have a negative impact on the current growth momentum. Instead, it will cool down the overheated investment in such industries as real estate, metallurgy and non-ferrous metal industries.

With those industries registering fast growth records in recent years, banks have been passionate in granting unsecured credit, which has contributed to excessive investments in those industries. It has also led to increased debt risks on banks and local governments.

Gradually withdrawing the treasury bonds can help cool the investment fever in those sectors and protect banks from being trapped in a new round of bad loans.

Last but not least, the gradual phase-out of the treasury bond policy will help ease inflation pressure.

Statistics from the central bank show that the surplus broad measurement of money supply, M2, which includes cash in circulation and all deposits, and the surplus narrow measurement of money supply, M1, which includes cash in circulation plus demand deposits, grew by 20.8 and 20.2 percent respectively in the first six months over the same period of last year. The M2 is at its highest level since 1998.

In the first half of the year, the total new renminbi lending was 1.781 trillion yuan (US$214.6 billion), 951.1 billion yuan (US$114.6 billion) more year on year.

It is thus foreseeable that the total new lending volume may exceed 3 trillion yuan (US$361.4 billion) this year, which is the highest level since the late 1970s.

The present growth momentum of bank loans has been disproportionate with the tempo of economic growth and price index movement, which means if the trend goes unchecked, inflation might surface in the next one or two years.

Although the price index of consumption commodities remains stable, which is around 1 percent, that of the means of production has risen by more than 5 percent, which is the highest margin since 1996. The effect of the sharp rise may spill over into the domain of the commodity price, pressuring it to go upward.

The gradual withdrawal of treasury bonds will dampen the excessive demand for means of production and thus ease the inflation pressure.

The authors are researchers with the Research Institute of Macro Economy under the State Development and Reform Commission.

(China Daily December 10, 2003)